Solving the B-School Tax Riddle: A Proposal To Clarify the ...

Solving the B-School Tax Riddle: A Proposal ToClarify the Confusion Surrounding Deductions forMBA-Related Educational Expenditures Under§ 162 of the Internal Revenue Code

JOHN J. DEBOY*

TABLE OF CONTENTS

INTRODUCTION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1690

I. BACKGROUND: SORTING THROUGH THE MBA TAX RIDDLE . . . . . . . . 1691

A. SECTION 162 AND TREASURY REGULATION § 1.162-5 . . . . . . . . . . . 1691

B. TAX COURT TREATMENT OF MBA-RELATED TUITION EXPENSES . . . 1694

1. Victory for the IRS: Cases Decided in Favor of theCommissioner . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1695

2. Victory for the MBA: Cases Decided in Favor of theTaxpayer . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1696

3. Making Some Sense of the Confusion: Synthesis ofImbedded Rules . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1698

C. THE FLAWED CASE FOR BLANKET DISALLOWANCE: OVERVIEW OF

RECENT COMMENTARY . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1699

II. A CRITICAL TAX POLICY CONSIDERATION: NOT ALL MBAS ARE

CREATED EQUAL . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1701

A. CERTIFICATION, LICENSURE, AND MINIMUM QUALIFICATION:CRITICAL DIFFERENCES BETWEEN THE MBA AND OTHER

PROFESSIONAL DEGREES . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1701

B. THE CAREER-TRANSFORMING MBA: A REALITY FOR THE

ELITE FEW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1704

C. THE OBVIOUS OVERBREADTH OF BLANKET DISALLOWANCE . . . . . . 1707

* Georgetown Law, J.D. expected 2010; University of Chicago, M.B.A. 2003; University of NotreDame, B.A. 1997. © 2009, John J. DeBoy. The author wishes to thank Professor Ronald Pearlman forhis guidance throughout the development of this paper. He also wishes to thank the staff and editors ofThe Georgetown Law Journal for their editorial assistance, especially Jennifer Xi and Brandon Smith.Most importantly, he wishes to thank his wife, Cindy, and daughter, Caitlin, whose love, support, andpatience have carried him through so many challenges.

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III. A NEW WAY FORWARD: PROPOSED MODIFICATIONS TO TREASURY

REGULATION § 1.162-5 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1708

A. PROHIBITION OF EXTENDED FULL-TIME STUDY . . . . . . . . . . . . . . 1709

B. COURSE-BY-COURSE EVALUATION OF DEDUCTION ELIGIBILITY . . . 1710

C. IMPLEMENTATION OF A “TWENTY-FIVE PERCENT” RULE . . . . . . . . 1712

CONCLUSION . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1713

INTRODUCTION

The deductibility of tuition expenses for coursework toward a Master ofBusiness Administration (MBA) degree has confounded taxpayers and thecourts for decades. Specifically, courts have frequently struggled in their effortsto determine whether MBA-related tuition expenses fall within the InternalRevenue Code’s express allowance—codified in § 162—of deductions for“ordinary and necessary expenses paid or incurred . . . in carrying on any tradeor business.”1 A source of particular confusion is Treasury Regulation § 1.162-5’s disallowance of educational expenses which are “part of a program of studybeing pursued by [the taxpayer] which will lead to qualifying him in a newtrade or business.”2

Recently, in an effort to resolve conflicting court decisions on this issue, atleast one commentator has called for a bright-line disallowance of deductionsfor MBA-related educational expenditures.3 This Note takes a different standand argues that a blanket disallowance of deductions for MBA tuition expenseswould constitute an overbroad rule that would result in the exclusion of manydeductions entirely consistent with the policy motivations underlying § 162 ofthe Internal Revenue Code.4 This Note also recommends modifications toTreasury Regulation § 1.162-5 that, if promulgated, would permit deductions

1. 26 U.S.C. § 162(a) (2006).2. Treas. Reg. § 1.162-5(b)(3)(i) (as amended in 1967).3. See Jill Kutzbach Sanchez, Note, The Deductibility of MBA Degree Expenses Under Treasury

Regulation 1.162-5: Are You One of the Lucky Few Who Qualify?, 32 J. CORP. L. 659, 675 (2007).4. As articulated by many commentators, the purpose of § 162 is to permit deductions for the costs

of doing business—that is, the costs of engaging in one’s trade or profession—but not for costsassociated with personal consumption, which are expressly disallowed by § 262 of the Internal RevenueCode. See, e.g., James L. Musselman, Federal Income Tax Deductibility of Higher Education Expenses:The Good, the Bad, and the Ugly, 35 CAP. U. L. REV. 923, 924–27 (2007); Hamish P. M. Hume, Note,The Business of Learning: When and How the Cost of Education Should Be Recognized, 81 VA. L. REV.887, 890–97 (1995); see also 26 U.S.C. § 262(a) (“Except as otherwise expressly provided in thischapter, no deduction shall be allowed for personal, living, or family expenses.”). If Treasury Regula-tion § 1.162-5 is any guide, the Treasury appears to view education not directly attributable to one’scurrent trade or profession—such as education that facilitates the taxpayer’s professional “reinvention”or entree into a new trade—as having a significant, perhaps even dominant, personal consumptioncomponent. See Treas. Reg. § 1.162-5(b)(1) (as amended in 1967). As this analysis ultimately willdemonstrate, however, many MBA educations pass muster even under the Treasury’s rather narrowinterpretation of §§ 162 and 262.

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consistent with the purpose of § 162 while simultaneously disallowing mostdeductions for educational expenditures that would reasonably lead to qualifica-tion “in a new trade or business.” In so recommending, this Note examines akey policy consideration missed by those who call for blanket disallowance:The majority of MBA educations do not, despite suggestions to the contrary,reasonably result in virtually automatic qualification in new trades or busi-nesses.

Part I of this Note will provide relevant background, beginning with anoverview of § 162 and Treasury Regulation § 1.162-5, continuing with a surveyof court cases addressing the question of MBA tuition deductibility over theyears, and concluding with a discussion of recent commentary on the issue. PartII will make the case for MBA tuition deductibility in most cases, in large partby refuting the argument that the MBA degree results in virtually automaticqualification in new trades and businesses. Finally, Part III will outline threeproposed amendments to § 1.162-5 that, if implemented, would more cleanlyseparate legitimate MBA-related deductions from those likely to offend thepolicy motivations behind § 162.

Ultimately, the goal of this Note is threefold: first, to demonstrate that mostMBA educations do not offend the Treasury Department’s professed policyagainst deductions for educational expenses that lead to the qualification of ataxpayer in a new trade or business; second, to dispel the argument—oneadopted not only by at least one recent commentator, but also quite possibly bythe enforcement arm of the IRS itself—that blanket disallowance is appropriatein cases involving tax deductions for MBA-related expenditures; and third, tooutline possible changes to Treasury Regulation § 1.162-5 that would serve tomore closely align MBA-related deductions with Treasury Department policy.

I. BACKGROUND: SORTING THROUGH THE MBA TAX RIDDLE

Although § 162 of the Internal Revenue Code and its accompanying regula-tions permit deductions for educational expenditures under certain circum-stances, courts have long struggled in their efforts to apply the applicable legalstandards in cases involving MBA-related deductions. Although some coherentprinciples can be synthesized through a careful review of what might at firstblush appear to be conflicting court rulings, a few recent commentators haveasserted that MBA-related expenditures rarely—if ever—satisfy the legal require-ments for deductibility. In fact, at least one commentator has argued that theTreasury should enact a blanket disallowance of all deductions for MBA-relatededucational expenditures.5

A. SECTION 162 AND TREASURY REGULATION § 1.162-5

Section 162 of the Internal Revenue Code permits deductions for “all the

5. See Sanchez, supra note 3, at 675.

2009] 1691SOLVING THE B-SCHOOL TAX RIDDLE

ordinary and necessary expenses paid or incurred during the taxable year incarrying on any trade or business.”6 As a matter of policy, § 162 codifies thelong-recognized principle that, generally speaking, ordinary business expensesconstitute the costs of generating income—as opposed to consumption orpersonal expenditures—and therefore are not properly includable in a taxpay-er’s taxable “bottom line.”7 As express examples of expenses normally deduct-ible as “ordinary and necessary” business expenditures, § 162 offers thefollowing: “salaries or other compensation for personal services,”8 “travelingexpenses . . . while away from home in the pursuit of a trade or business,”9 and“rentals or other payments required to be made as a condition to the continueduse or possession . . . of property.”10

Although § 162 itself makes no express mention of educational expenses,§ 1.162-5 of the Treasury Regulations11 outlines the circumstances under whichexpenses for education may be deductible as “ordinary and necessary” businessexpenditures under § 162. Pursuant to § 1.162-5, educational expenses aredeductible under § 16212 if all three of the following conditions are satisfied: (1)the education “[m]aintains or improves skills required” by the taxpayer in hisemployment, trade, or business,13 or meets express requirements imposed bythe taxpayer’s employer or by applicable law as a condition to the retention ofthe taxpayer’s established employment, status, or rate of compensation;14 (2)the education is not required in order to meet the minimum educational require-ments for qualification in the taxpayer’s employment, trade, or business;15 and(3) the education is not part of a program of study that will lead to qualifyingthe taxpayer in a new trade or business, irrespective of whether the taxpayeractually intends to enter the trade or business for which the program of study

6. 26 U.S.C. § 162(a).7. See, e.g., Henderson v. Comm’r, 46 T.C.M. (CCH) 566 (1983) (noting the distinction between

deductible costs of doing business and “personal, living, or family expense[s]”).8. 26 U.S.C. § 162(a)(1).9. Id. § 162(a)(2).10. Id. § 162(a)(3).11. Pursuant to § 7805 of the Internal Revenue Code, the Secretary of the Treasury has the authority

to “prescribe all needful rules and regulations for the enforcement of” the Code, except where suchauthority is expressly given to others. Id. § 7805(a). Such rules and regulations promulgated by theSecretary are codified in the Treasury Regulations.

12. A minor caveat worth mentioning here is that educational expenses deducted under § 162constitute “miscellaneous itemized deductions” within the meaning of the Internal Revenue Code andare therefore deductible only to the extent that they exceed [two] percent of the taxpayer’s adjustedgross income—even if all other statutory and regulatory requirements are satisfied. See id. § 67(a) (“Inthe case of an individual, the miscellaneous itemized deductions for any taxable year shall be allowedonly to the extent that the aggregate of such deductions exceeds two percent of adjusted grossincome.”). For instance, a taxpayer with an adjusted gross income of $100,000, $20,000 in permissibleeducational expenses, and no other miscellaneous deductions would only be allowed to deduct $18,000of his educational expenses, as that is the amount by which the aggregate of his miscellaneous itemizeddeductions ($20,000) exceeds two percent of his adjusted gross income ($2,000).

13. Treas. Reg. § 1.162-5(a)(1) (as amended in 1967).14. Id. § 1.162-5(a)(2).15. See id. § 1.162-5(b)(2)(i).


qualifies him.16 Where a taxpayer’s educational expenditures fail to satisfy anyone of these three requirements, the costs constitute personal expenditures17 andtherefore are not deductible as “ordinary and necessary” business expendituresunder § 162.18

In addition to outlining the general rules governing the deductibility ofeducational expenses under § 162, § 1.162-5 provides several examples ofexpenditures that satisfy the regulation’s requirements as well as examples ofthose that do not. For instance, the regulation specifically states that an aspiringattorney may not deduct the costs associated with law school and bar prepara-tion courses because such courses “constitute education required to meet theminimum educational requirements for qualification in [the student’s] trade orbusiness”19 and are part of a course of study that “qualifies him for a new tradeor business.”20 On the other hand, the regulation notes that a general practitio-ner of medicine who takes a two-week course reviewing “new developments inseveral specialized fields of medicine” may deduct the costs associated with thecourse because the course “maintains or improves skills required by him in histrade or business and does not qualify him for a new trade or business.”21

Conspicuously absent from § 1.162-5’s many examples is any mention ofeducational expenses incurred in pursuit of an MBA. One possible explanationfor this omission is the fact that an MBA degree—unlike a law degree, amedical degree, or a degree in education—is not an express requirement forlicensure in any particular profession, nor are the courses that comprise thedegree “refresher” or “update” courses of the sort that one might typically placein a “continuing education” category. In other words, MBA courses fall into a

16. See id. § 1.162-5(b)(3).17. Though not dictated by statute, the Treasury has long taken the position that virtually all

expenditures for education are personal expenditures and are therefore not eligible for deduction oramortization under § 162 or any other provision of the Internal Revenue Code, even where suchexpenditures—for instance, the costs associated with obtaining a bachelor’s degree in engineering, anecessary prerequisite for a career in the engineering field—have a clear connection to one’s trade orbusiness. See, e.g., David S. Davenport, Education and Human Capital: Pursuing an Ideal Income Taxand a Sensible Tax Policy, 42 CASE W. RES. L. REV. 793, 805–10 (1992). The exceptions to that generalrule, including those promulgated in Treasury Regulation § 1.162-5, which appear to be aimed atisolating those educational expenditures that do not have a significant “personal consumption” compo-nent, are quite narrow indeed. Scholars disagree as to why the Treasury has assumed such a restrictiveview of the deductibility of educational expenditures over time. Some attribute the government’sposition to concerns regarding “the practical problems of judicial and administrative line drawingbetween those education expenditures for which cost recovery arguably should be allowed and thosethat might be viewed as costs of personal consumption.” Id. at 797. Others argue that the restrictiveposition is justified on the grounds that the benefits of deductions for educational expenditures mightaccrue in large part to those who least need them, such as those in the more affluent segments ofsociety. Id. at 797–98. Nevertheless, many observers bristle at “the notion that the joys of obtaining a[professional education] are considered to be akin to the personal consumption involved in renting theirapartments, consuming pizza, or watching the Red Sox chase a pennant.” Id. at 811–12.

18. See Treas. Reg. § 1.162-5(b)(1) (as amended in 1967).19. Id. § 1.162-5(b)(2)(iii), Example (3).20. Id. § 1.162-5(b)(3)(ii), Example (1).21. Id. § 1.162-5(b)(3)(ii), Example (3).


peculiar middle ground between courses that clearly lead to qualification in anew trade or business and those that merely improve or maintain skills that thetaxpayer already has acquired; for this reason, they do not lend themselves tobright-line distinctions and clear examples under the rules articulated in § 1.162-5.Another possible explanation for the absence of any mention of the MBA in§ 1.162-5 is that when the regulation was drafted in 1967 the degree was far lessubiquitous than it is today, perhaps making it an unattractive (or non-obvious)candidate for mention in the regulation’s many examples.22

In any event, all possible explanations aside, it remains plain that neither§ 162 nor § 1.162-5 offers clear guidance with respect to the deductibility ofeducational expenses incurred in pursuit of an MBA.23 This explains, at least inpart, why the courts have long struggled with cases involving disputes overMBA-related deductions.

B. TAX COURT TREATMENT OF MBA-RELATED TUITION EXPENSES

As noted in section I.A, the courts often have struggled when confronted withthe question of whether MBA-related educational expenditures are deductible as“ordinary and necessary” business expenditures under § 162. Although thequestion of whether a particular MBA curriculum improved or maintained skillsused by the taxpayer in his established profession has rarely been contested—provided, of course, that the taxpayer was in fact firmly established in a trade orprofession prior to pursuing an MBA24—much ink has been spilled in dis-putes25 over the following: (1) whether the taxpayer remained engaged in atrade or profession while pursuing his MBA and (2) whether the taxpayer’sMBA coursework qualified him in a new trade or profession. Results have not

22. See Jeffrey Pfeffer & Christina T. Fong, The End of Business Schools? Less Success than Meetsthe Eye, 1 ACAD. MGMT. LEARNING & EDUC. 78, 78 (2002), available at http://www.aomonline.org/Publications/Articles/BSchools.asp (“For instance, in 1955–56, graduate business education was virtu-ally nonexistent, with only 3,200 MBA degrees awarded in the U.S. By 1997–98, this number hadgrown to over 102,000.” (internal quotation marks omitted)).

23. The regulatory history of Treasury Regulation § 1.162-5 similarly provides no guidance regard-ing the deductibility of MBA-related educational expenses. For instance, the Treasury Decisionpublished when the regulation was amended in 1967 provides little more than the regulation’s amendedtext. See T.D. 6918, 1967-1 C.B. 36. In addition, a visit to the Freedom of Information Reading Roomat the Internal Revenue Service headquarters in Washington, D.C. unearthed no Technical Memoran-dum or other internal agency document providing insight into the Treasury Department’s opinionsregarding the deductibility of MBA educations.

24. Cf. Link v. Comm’r, 90 T.C. 460, 461–62, 464–65 (1988) (finding that a recent college graduatewho left his job as a market research analyst to pursue an MBA a mere three months after graduatingfrom college had not engaged in “considerable, continuous, and regular activity” sufficient to establishhim in a trade or business prior to pursuing a graduate education).

25. See, e.g., Allemeier v. Comm’r, 90 T.C.M. (CCH) 197 (2005); Schneider v. Comm’r, 47 T.C.M.(CCH) 675 (1983). Although the IRS disallows deductions for MBA-related educational expenditureswith some frequency, the precise standards that it applies in determining whether a given businessschool student’s educational expenditures should be disallowed remain somewhat unclear. The InternalRevenue Manual makes no mention of MBA-related educational expenditures and generally includesvery little discussion of Treasury Regulation § 1.162-5.


always been consistent—at least when viewed in terms of the broad question ofwhether MBA-related expenditures are deductible under § 162—because out-comes frequently have turned on the factual peculiarities of cases, often afterdetailed analysis of the taxpayer’s behavior both before and after pursuit of theMBA degree. Nevertheless, a careful review of court opinions addressing MBAdeductibility reveals several common principles that may serve as the founda-tion for amendments to Treasury Regulation § 1.162-5.

1. Victory for the IRS: Cases Decided in Favor of the Commissioner

In many cases, courts have ruled in favor of the Commissioner and againstthe taxpayer. For instance, in Schneider v. Commissioner, the United States TaxCourt ruled against a former Army officer with considerable management andleadership experience who left military service to pursue a full-time MBA at theHarvard Business School and a full-time Master of Public Administration(MPA) degree at Harvard’s Kennedy School of Government.26 Following comple-tion of both programs, the taxpayer began a career as a business strategyconsultant.27 He deducted costs associated with his MBA education on his 1977and 1978 tax returns, which the Commissioner disallowed.

In ruling against the taxpayer, the Schneider court determined that he was not“carrying on” a trade or business during his time at Harvard and that hiseducation clearly qualified him for a new trade or business.28 Specifically, thecourt found that the taxpayer’s absence from work was not temporary anddefinite, and therefore, it could not reasonably be argued that he was “carryingon” a trade or business while enrolled at Harvard.29 Moreover, although thetaxpayer had accumulated considerable leadership experience during his tenureas an Army officer, the court found that his military skills were insufficientlyrelated to his MBA courses and his post-MBA career to support the assertionthat he was engaged in the trade or business of being a “manager” before,during, and after his time at Harvard; this, the court argued, inevitably led to theconclusion that the taxpayer’s MBA degree qualified him in a new trade orprofession—that of a business strategy consultant—which in turn rendered hiseducational expenses non-deductible under § 1.162-5.30

26. Schneider v. Comm’r, 47 T.C.M. (CCH) 675, 676–77, 680 (1983).27. Id. at 677.28. Id. at 678.29. Id. The court asserted that

when a taxpayer leaves his trade or business for a prolonged period of study with no apparentcontinuing connection with either his former job or any clear indication of an intention toactively carry on the same trade or business upon completion of study, the taxpayer is not“carrying on” his trade or business while attending school.

Id. at 680 n.6 (quoting Sherman v. Comm’r, 36 T.C.M. (CCH) 1191 (1977)).30. Id. at 678–79. The court stated that “petitioner’s work as an Army officer is a different trade or

business from the consulting business for which his course of study at Harvard prepared him.” Id. at679.


Similarly, in McEuen v. Commissioner, the United States Tax Court held thata graduate of Northwestern University’s Kellogg School of Management couldnot deduct the costs of her MBA education because the degree program led toqualifying her in a new trade or business.31 The McEuen taxpayer enrolled atKellogg as a full-time student after spending four years as a financial analyst attwo different investment banking firms.32 After completing her MBA, sheentered a management development program at a home furnishings manufac-turer. Upon completion of the management development program, she becamean associate brand manager for the same manufacturer. On her 1998 income taxreturn, the taxpayer claimed a deduction of $20,317 for “required education.”

In ruling against the taxpayer and in favor of the Commissioner, the McEuencourt found that the taxpayer’s acceptance into her post-graduate employer’smanagement development program—a program that recruited actively at topbusiness schools—and her ultimate assumption of a brand manager positionunrelated to her pre-MBA career made it plain that her MBA education “led toqualifying her to perform significantly different tasks and activities than sheperformed before the education.”33 This, the court said, served as evidence thather education had qualified her for a new trade or business and thus renderedher educational expenses non-deductible under § 162.34

2. Victory for the MBA: Cases Decided in Favor of the Taxpayer

In numerous other cases, however, courts have ruled in favor of taxpayersseeking to deduct MBA-related expenses. For instance, in Blair v. Commis-sioner, the Tax Court ruled in favor of a personnel representative employed bySherwin-Williams who completed a two-year part-time MBA program at Bald-win-Wallace College.35 While her studies were in progress, but prior to theircompletion, the taxpayer received a promotion to personnel manager. Shededucted costs associated with her MBA education on her 1975 and 1976 taxreturns.36

In ruling in the personnel manager’s favor, the Blair court concluded that,although she received a promotion while her MBA courses were in progress, herelevation from personnel representative to personnel manager constituted a

31. McEuen v. Comm’r, T.C. Summ. Op. 2004-107.32. Id.33. Id.34. Id. Note that Schneider and McEuen represent only two of several cases in which courts have

ruled against taxpayers seeking to deduct MBA-related expenses. See, e.g., Foster v. Comm’r, T.C.Summ. Op. 2008-22 (holding that an engineer and project manager who pursued a full-time MBA at theHarvard Business School could not deduct the costs of her education because she did not possess theskills required in her post-MBA marketing job prior to matriculating at business school); McIlvoy v.Comm’r, 38 T.C.M. (CCH) 987 (1979) (holding that an engineer with few, if any, business-relatedresponsibilities could not deduct the costs of his MBA education because his MBA courses taught himentirely new skills and therefore did not improve or maintain existing skills within the meaning ofTreasury Regulation § 1.162-5).

35. Blair v. Comm’r, 41 T.C.M. (CCH) 289, 290 (1980).36. Id. at 289, 291.


change of duties as opposed to a transition into a new trade or business.37 Inaddition, the court noted that, with the exception of a single course for whichthe taxpayer did not claim a deduction, all of her MBA courses improved ormaintained skills that she had already acquired in her job at Sherwin-Williams.38

Much more recently, in Allemeier v. Commissioner, the Tax Court ruled infavor of a salesman and marketing manager for a dental appliance manufacturerwho completed a part-time MBA program at Pepperdine University.39 Through-out the duration of his MBA studies, the taxpayer worked for his employer on afull-time basis. He also continued to work for the same employer in the samegeneral capacity after completing the degree. Moreover, prior to completing hisMBA, he already had assumed significant managerial, marketing, and businessstrategy duties.40 On his 2001 income tax return, the taxpayer deducted $17,500of tuition expenses associated with his MBA education, which the Commis-sioner subsequently disallowed.41

The Allemeier court rejected the Commissioner’s arguments that the taxpayerpursued an MBA in order to meet the minimum education requirements of hisemployer and that his MBA degree qualified him for a new trade or business.42

In so holding, the court concluded that nothing in the record supported theCommissioner’s contention that the taxpayer’s employment or promotions werecontingent upon his completion of an MBA program.43 The court also assertedthat because the taxpayer’s duties did not change markedly during or after thecompletion of his MBA studies, and because his MBA did not qualify him for aprofessional certification or license, the record strongly suggested that thetaxpayer’s MBA education did not qualify him for a new trade or business.44

Specifically, the court declined “to find as an objective matter that the MBAqualified petitioner in a ‘new’ trade or business, where petitioner had substantialwork experience directly related to his MBA coursework. The MBA qualifiedpetitioner to perform the same general duties he performed before enrolling inthe MBA program.”45

37. Id. at 291–92.38. Id. at 292.39. Allemeier v. Comm’r, 90 T.C.M. (CCH) 197, 197–98 (2005).40. Id. at 198, 200.41. Id. at 198.42. Id. at 199, 201.43. Id. at 199.44. Id. at 199–200.45. Id. at 201 (citation omitted). Courts have similarly found for the taxpayer on several other

occasions. See, e.g., Beatty v. Comm’r, 40 T.C.M. (CCH) 438 (1980) (holding that an engineer whopursued a Master of Science in Administration (MSA) degree on a part-time basis could deduct thecosts of his education because he had already assumed significant management responsibilities beforeentering graduate school, suggesting that the degree merely maintained or improved skills he hadalready acquired); Sherman v. Comm’r, 36 T.C.M. (CCH) 1191 (1977) (holding that a businessplanning manager who left work to pursue a full-time MBA and subsequently assumed a planning andresearch position with another employer could deduct the costs of his MBA education because a


3. Making Some Sense of the Confusion: Synthesis of Imbedded Rules

Despite the apparent lack of consistency among court decisions ruling on thedeductibility of MBA-related expenses, a review of the cases exposes a morecoherent series of underlying guiding principles. Specifically, an attentive analy-sis reveals at least three imbedded rules applied consistently across the variousMBA-related cases. First, absent some compelling distinguishing factor, the TaxCourt’s MBA-related decisions demonstrate that a student who pursues anMBA on a part-time basis while continuing to work in his established profes-sion is presumed to remain engaged in a trade or profession during his studies,whereas an MBA student who exits the workforce for an extended period oftime to pursue graduate study full-time is presumed to be not so engaged.46

Second, the decisions reveal that where an MBA student remains engaged in hispre-MBA profession after completion of his degree, it is presumed that hisdegree has not qualified him for a new trade or profession, whereas a studentwho transitions into a new trade or profession shortly after completing hisstudies is practically per se considered to have become qualified for a new tradeor profession as a result of his MBA degree.47 Finally, the decisions teach thatthe MBA-related expenses of a student who did not acquire substantial busi-ness- or management-related skills prior to pursuing an MBA are per senon-deductible under § 162.48

These three guiding principles, which will be unpacked further in Part III,will serve as the foundation of this Note’s proposal to update Treasury Regula-tion § 1.162-5. The goal, ultimately, is to guide courts and taxpayers morecoherently in their efforts to determine when educational expenses—and MBAexpenses in particular—are, or are not, deductible under § 162.

taxpayer who temporarily ceases employment for a definite period of time in order to pursue full-timestudy may still be “carrying on” a trade or business while in school).

46. See Foster v. Comm’r, T.C. Summ. Op. 2008-22 (disallowing a deduction for full-time MBAstudy); Allemeier v. Comm’r, 90 T.C.M. (CCH) 197 (2005) (permitting a deduction for part-time MBAstudy); McEuen v. Comm’r, T.C. Summ. Op. 2004-107 (disallowing a deduction for full-time MBAstudy); Link v. Comm’r, 90 T.C. 460 (1988) (same); Schneider v. Comm’r, 47 T.C.M. (CCH) 675(1983) (same); Beatty, 40 T.C.M. (CCH) at 438 (permitting a deduction for part-time MBA study);Blair v. Comm’r, 41 T.C.M. (CCH) 289 (1980) (same). But see Sherman, 36 T.C.M. (CCH) at 1191(permitting a deduction for full-time MBA study).

47. See Foster, T.C. Summ. Op. 2008-22 (disallowing a deduction where the student’s pre- andpost-MBA professions differed); Allemeier, 90 T.C.M. (CCH) at 197 (permitting a deduction where thestudent’s pre- and post-MBA professions were the same); McEuen, T.C. Summ. Op. 2004-107 (disallow-ing a deduction where the student’s pre- and post-MBA professions differed); Schneider, 47 T.C.M.(CCH) at 675 (same); Beatty, 40 T.C.M. (CCH) at 438 (permitting a deduction where the student’s pre-and post-MBA professions were the same); Blair, 41 T.C.M. (CCH) at 289 (same); Sherman, 36 T.C.M.(CCH) at 1191 (same).

48. See Allemeier, 90 T.C.M. (CCH) at 197 (permitting a deduction where the student had obtainedsubstantial business- or management-related skills before pursuing an MBA); Beatty, 40 T.C.M. (CCH)at 438 (same); Blair, 41 T.C.M. (CCH) at 289 (same); McIlvoy v. Comm’r, 38 T.C.M. (CCH) 987(1979) (disallowing a deduction where the student had obtained few, if any, business-related skillsbefore pursuing an MBA).


C. THE FLAWED CASE FOR BLANKET DISALLOWANCE: OVERVIEW OF RECENT

COMMENTARY

Although the deductibility of educational expenses incurred in pursuit of anMBA is hardly a topic of substantial scholarly discourse, a few recent commen-tators have explored the issue and have concluded, largely without factualsubstantiation, that the MBA degree almost always—if not always—qualifies astudent in a new trade or business and is therefore nearly always violative ofTreasury Regulation § 1.162-5.49 One commentator has even gone so far as tocall for a bright-line disallowance of deductions for MBA-related educationalexpenditures on the grounds that “[w]hen a taxpayer obtains an MBA degree, heor she is qualified to enter many new trades and businesses.”50 Although theseanalyses include many legitimate critiques of the courts’ MBA-related deci-sions,51 they ultimately fail—at least in significant part—because they neglectto examine whether their assertions regarding virtually automatic qualificationin a new trade or business have any basis in fact.

In a 2007 article in The Journal of Corporation Law, Jill Kutzbach Sanchezargues that the difficulties inherent in applying Treasury Regulation § 1.162-5 toMBA-related educational expenses, combined with confusing and conflictingcourt decisions on the issue, have led to disparate treatment of taxpayers, taxavoidance schemes, and unnecessary administrative costs in the form of numer-ous disputes between taxpayers and the IRS.52 To alleviate such problems, sheultimately calls for the blanket disallowance of deductions for expenses in-curred in pursuit of an MBA.53 While some, though certainly not all,54 ofSanchez’s many critiques have merit, a critical weakness of her analysis is herfailure to substantiate her oft-stated—and heavily relied upon—assumption thatthe MBA degree essentially results in automatic qualification in new trades orprofessions.55 Absent factual support for her claim that MBA expenditures

49. See Sanchez, supra note 3, at 676 (asserting, without factual support, that an MBA automaticallyqualifies a taxpayer to “enter many new trades and businesses”); Robert A. Stolworthy, Jr., Note, NoM.B.A. Left Behind: Professional Education as a Business Expense in Allemeier v. Commissioner, 59TAX LAW. 927, 928 (2006) (asserting that “graduate education leading to a degree only rarely passes thenew trade or business test”).

50. Sanchez, supra note 3, at 676.51. For instance, the Sanchez and Stolworthy notes both criticize the courts’ tendency to apply what

is widely held to be an objective test—whether a given course of study qualified the taxpayer for a newtrade or profession—in a manner that focuses on the taxpayer’s subjective intent. See id. at 666;Stolworthy, supra note 49, at 927, 934–35.

52. See Sanchez, supra note 3, at 669.53. Id. at 675 (“The courts and the IRS should not allow taxpayers to deduct educational expenses

incurred to obtain an MBA degree under any circumstances.”).54. Sanchez’s concerns regarding tax avoidance schemes, for instance, are purely theoretical. While

she argues that the current regulations make it possible for employers and employees to conspire toescape taxation of MBA-related expenditures, she cites to no case or other authority showing thatemployers and employees have in fact implemented such schemes. See id. at 675.

55. As the sole support for her argument that the MBA degree results in virtually automaticqualification in new trades or professions, Sanchez cites to a web site that provides advertising servicesfor business schools. See id. at 671 & nn.120–21 (citing All Business Schools, Finance Career Resource


almost always will fail § 1.162-5’s prohibition against education leading toqualification in a new profession, Sanchez’s call for across-the-board disallow-ance of MBA-related deductions appears at best premature, and perhaps unnec-essarily overbroad.

Similarly, in a 2006 article published in The Tax Lawyer, Robert Stolworthy,Jr. argues—again without much substantiation—that graduate education leadingto a degree, including courses taken in pursuit of an MBA, “only rarely passesthe new trade or business test.”56 While Stolworthy’s conclusions are consider-ably less bold than those of Sanchez—he does not call for blanket disallowance,and instead focuses his analysis on criticizing the manner in which the courtshave applied § 1.162-5’s existing tests57—he, too, relies at least in part on animplicit and largely unsupported assumption that an MBA nearly always quali-fies a taxpayer in new trades or professions. Like Sanchez, he leaves a criticalfactual consideration virtually unexamined.

Thus, although commentators who have recently examined the question ofMBA deductibility have offered some helpful insights, their analyses—particularly to the extent that they lean heavily in favor of non-deductibility—suffer from a failure to carefully examine the underlying assumption that anMBA education nearly always constitutes a career-transforming undertaking.This Note attempts to remedy that error by examining the legitimacy of theproposition that the MBA degree gives rise to qualification in new trades andprofessions virtually as a matter of course.58

Guide, http://www.allbusinessschools.com/faqs/finance.php (last visited Mar. 19, 2009)). Moreover, theweb site she references hardly asserts that an MBA results in automatic qualification in certain trades orprofessions; rather, it merely discusses the types of career opportunities that may be available tograduates of MBA programs. See id.

56. See Stolworthy, supra note 49, at 928. To be fair, Stolworthy’s argument that graduate educationleading to a degree only rarely passes the new trade or business test is based largely upon a legalanalysis of cases in which courts ruled against the taxpayer—as opposed to a direct assertion that theMBA degree grants, as a matter of fact, virtually automatic entry into new trades or businesses. See id.at 932–33. Peculiarly, Stolworthy devotes little analysis to the several cases—other than Allemeier—inwhich courts have ruled in favor of taxpayers who deducted MBA-related expenses.

57. See id. at 933–35 (analyzing the Allemeier court’s use of subjective factors in the application ofan objective test).

58. It is important to note here that the call for blanket disallowance is not a purely academicexercise, nor is it the far-reaching idea of a single commentator. In fact, despite its flaws, it wouldappear that the blanket approach may very well be the current official policy of the Services andEnforcement arm of the IRS itself. As evidenced by the IRS’s tendency to disallow MBA-relateddeductions even in cases where the taxpayer’s arguments for deductibility are compelling, see Alle-meier v. Comm’r, 90 T.C.M. (CCH) 197 (2005), it would appear that, in recent years, the agency’senforcement arm has adopted a strict policy of rejecting such deductions in most, if not all, circum-stances. This development has not gone unnoticed by tax practitioners and the popular business press.See, e.g., Albert B. Crenshaw, A Little Learning Is a Dangerous Thing To Deduct, WASH. POST, Aug. 22,2004, at F4 (noting that the IRS has begun to take a “hard line” on deductions for MBA-relatededucational expenditures); Jane J. Kim, M.B.A. Students May Lose Tax Break, WALL ST. J., Aug. 17,2004, at D2 (noting that the IRS has increasingly begun to challenge taxpayers’ ability to deductMBA-related educational expenses and quoting a practitioner who asserted that “you’d have to bepretty bold to take a deduction at this point”).


II. A CRITICAL TAX POLICY CONSIDERATION: NOT ALL MBAS ARE CREATED

EQUAL

Two important considerations counsel against the conclusion that the MBAdegree nearly always results in qualification in new trades or professions. First,unlike many other professional degrees, the MBA does not lead to certificationor licensure in any particular trade or profession nor does it satisfy the minimumeducational requirements of any non-regulated profession or industry. Second,despite its reputation as a career-transforming degree, the most lucrative ben-efits of an MBA education typically accrue only to the graduates of a smallnumber of elite schools. Given these considerations, it is plain that, for manytaxpayers, MBA-related expenses remain squarely within the boundaries of thetax policy motivations behind § 162.

A. CERTIFICATION, LICENSURE, AND MINIMUM QUALIFICATION: CRITICAL DIFFERENCES

BETWEEN THE MBA AND OTHER PROFESSIONAL DEGREES

Unlike a law degree, a medical degree, a nursing degree, or a master’s degreein social work, an MBA does not render one eligible for certification orlicensure in any particular trade or business. Moreover, following recent develop-ments in industries that traditionally required an MBA for advancement, thedegree is no longer required for entry into, or progression through, any particu-lar non-regulated trade, business, or profession. Although certainly not disposi-tive of the question explored here, these findings counsel against the conclusionthat an MBA automatically qualifies a graduate in new trades or professions.

That the MBA degree does not qualify one for official licensure or certifica-tion in any particular trade or business is a virtually uncontested fact.59 Indeed,even those who maintain that the MBA results in automatic qualification in newtrades or professions concede the point. For instance, in her article calling forblanket disallowance of deductions for MBA-related educational expenditures,Jill Kutzbach Sanchez recognizes that “the law does not require individuals toobtain a license or certificate to engage in the profession of an MBA as it doesfor the medical, legal, and accounting professions.”60 In addition, the courtshave similarly recognized the distinction between the MBA and degrees thatlead to licensure or certification. In ruling in favor of the taxpayer in Allemeier,for example, the Tax Court relied in part on its finding that “[p]etitioner’s MBAwas not a course of study leading him to qualify for a professional certificationor license.”61

59. See, e.g., Kim, supra note 58 (quoting a tax journal editor who noted that “there is no legalimpediment to getting a job without an M.B.A. as there would be for careers that have licensingrequirements”).

60. Sanchez, supra note 3, at 670; see also Robert Willens, Deducting an MBA Candidate’sEducation Expenses, 121 TAX NOTES 415, 415 (2008) (“[I]t seems intuitive . . . that the MBA does notqualify the student to engage in a new trade or business in the manner of a law or medical degree.”).

61. Allemeier v. Comm’r, 90 T.C.M. (CCH) 197, 200 (2005); see also Beatty v. Comm’r, 40 T.C.M.(CCH) 438 (1980) (“We also take note that petitioner’s course of study involved a broad, general


The importance and relevance of this distinction are evident in the illustrativeexamples outlined in Treasury Regulation § 1.162-5. Subsections (b)(2) and(b)(3) of that regulation—those governing the prohibitions against deductionsfor expenditures that meet minimum educational requirements and those thatlead to qualification in new trades or businesses, respectively—offer a total ofseven examples that illustrate the deductibility, or non-deductibility, of educa-tional expenditures under § 162.62 Tellingly, with one exception,63 every suchexample that demonstrates a scenario under which educational expenditures arenot deductible concerns a taxpayer who attempted to claim a deduction foreducation leading to official certification or licensure in a regulated profes-sion.64 If nothing else, this observation suggests that when it promulgated§ 1.162-5, the Treasury Department drew a distinction between courses thatclearly lead to official certification or licensure in some identifiable profession,and those that, like courses in business administration, might theoretically leadto qualification in some new trade or profession under certain circumstances.While disallowance of expenses incurred in pursuit of courses in the lattercategory might still be appropriate in certain cases, it is not unreasonable tointerpret § 1.162-5 as suggesting that such courses should not be subject toblanket disallowance, but instead should be evaluated in light of the factspresented in specific cases.

Also worthy of note is the fact that, in addition to not giving rise to officiallicensure or certification in any particular trade or profession, the MBA isarguably no longer even unofficially required for entry into, or continuingprogression through, any particular, business, profession, trade, or industry.Although an MBA was once deemed virtually required for long-term survival in

overview of the management and administrative operations of business life. There were no specializedprograms which would qualify a graduate, as a matter of technical training or as a pre-requisite toprofessional certification, for any particular trade, profession or business. Thus, petitioner’s studies arenot akin to those present in other cases which have disallowed deductions on new trade or businessgrounds. In the context of this case, we do not view the general study of business management andadministration as qualifying petitioner for a trade or business that is new and different than that whichhe was already engaged in.”).

62. See Treas. Reg. § 1.162-5(b)(2)–(3) (as amended in 1967).63. See id. § 1.162-5(b)(2), Example (2) (demonstrating disallowance of educational expenses

incurred by a university instructor in order to satisfy his employer’s minimum requirements forpermanent employment). In this scenario, however, the question is not whether the education at issuenecessarily qualified the instructor in a new trade or business, but rather whether the education wasnecessary to satisfy the minimum educational requirements of his current employer. This is not directlyrelevant to the question posed in this analysis, which is: Irrespective of the requirements of one’sparticular employer, does the MBA virtually always qualify a taxpayer in new trades or professions, andif so, should the Treasury Department implement a blanket disallowance for MBA-related deductionsclaimed under § 162?

64. See id. § 1.162-5(b)(2)(iii), Example (1), Situation (3) (demonstrating disallowance of educa-tional expenses incurred in order to satisfy requirements for state licensure as a secondary schoolteacher); id. § 1.162-5(b)(2)(iii), Example (3) (demonstrating disallowance of educational expensesincurred in pursuit of a law degree); id. § 1.162-5(b)(3)(ii), Example (1) (same); id. § 1.162-5(b)(3)(ii),Example (2) (same).


certain elite professions—investment banking and management consulting be-ing the most prominent examples—recent developments in those fields haveessentially rendered the degree optional.65 In investment banking, for instance,the most prominent firms traditionally required entry-level analysts to enroll inbusiness school after two or three years of work experience, permitting them toproceed to the more permanent position of associate only after completingMBAs.66 Now, however, the decision of whether to pursue an MBA is leftlargely to the employee because top banks routinely promote analysts directlyinto permanent associate-level positions without requiring a business schooldetour.67 The same is true of the management consulting industry, in which theMBA is no longer viewed as a requirement for entry or career progression—even at the most elite firms.68 Also telling is the fact that among top executivesat leading companies, fewer than one-third hold MBAs,69 which further sug-gests that the degree is hardly a requirement for entry into any particularindustry or for entry into business management generally.

What all of these findings suggest is that in the absence of a demonstrationthat the MBA is required for entry into certain trades, professions, or indus-tries—or at least for advancement therein—those who claim that the MBA

65. See Louise Story, Bye, Bye B-School, N.Y. TIMES, Sept. 16, 2007, § 3, at 1 (describing how manyelite professional services firms that once deemed the MBA degree a virtual necessity no longer requireit).

66. See id.; see also McEuen v. Comm’r, T.C. Summ. Op. 2004-107 (noting that, during thetaxpayer’s tenure as a financial analyst at two investment banking firms in the mid-1990s, “an M.B.A.degree was required to obtain a position as an associate with an investment banking firm”).

67. See Kim, supra note 58 (noting that “analysts in investment banks can be directly promoted tohigher associate levels” without first obtaining MBAs); Story, supra note 65 (“[I]nvestment banks likeGoldman Sachs and Credit Suisse have changed their tune on business school. Instead of pushing alltheir young employees into M.B.A. programs, banks are telling the best ones to stay put.”); see alsoWillens, supra note 60, at 415 (“In most cases, the MBA candidate will not run afoul of [the]prohibitions regarding the deductibility of education expenses. Most notably, for those candidates whowill be working at investment banks, hedge funds, or private equity firms, it seems clear beyond cavilthat the MBA degree is not a minimum educational requirement for securing a position at any of thoseorganizations. In fact, every investment bank has, at any one time, scores of employees functioning asassociates—the position the MBA candidate will occupy on graduation—who lack the MBA creden-tial.”); Merrill Lynch, Build a Career Foundation, http://careers.ml.com/?id�76716_79332_76756_76790_76795_76843_76852 (last visited Mar. 27, 2009) (indicating that, at Merrill Lynch, an MBA isnot required for progression from investment banking analyst to associate).

68. See Kim, supra note 58 (noting that an MBA is not required “to be a general manager or aconsultant”); McKinsey & Company, Roles and Career Paths, http://www.mckinsey.com/careers/is_mckinsey_right_for_me/roles_and_career_paths.aspx (last visited Mar. 24, 2009) (indicating that, atMcKinsey & Company, an elite management consulting firm, entry-level business analysts may bepromoted to associate with or without taking leave to pursue a graduate degree). Although the reasonsfor the industry’s shift away from the MBA requirement are not readily apparent, a possible explanationemerges in a widely-cited internal McKinsey study which found that the firm’s consultants with MBAsdid not outperform those consultants without the degree. See Heather Sokoloff, Little to Gain fromMBA Classes: Prof, CHI. SUN-TIMES, July 5, 2002, at 31 (citing a McKinsey study which found that,among consultants who had been on the job for one, three, and seven years, employees without anMBA were as successful as those who held the degree).

69. See Louis Lavelle, Is the MBA Overrated?, BUS. WK., Mar. 20, 2006, at 78 (finding that in 2004,only 146 of the 500 highest paid executives at S&P 100 companies held MBAs).


degree results in virtually automatic qualification in new trades or businessesmust hurdle a rather formidable obstacle in order to prove their point. Althoughit admittedly remains possible that an MBA might qualify certain individualtaxpayers for new trades or businesses under certain circumstances—a taxpayerwho pursues an MBA without first acquiring any business-related experiencecomes to mind here70—the case for blanket disallowance appears greatly dimin-ished in the absence of a showing that the degree plays a professional gate-keeping role akin to that of a law, medical, or nursing degree.

B. THE CAREER-TRANSFORMING MBA: A REALITY FOR THE ELITE FEW

Although the MBA arguably remains a career-transforming degree for gradu-ates of a small number of elite business schools, for graduates of most pro-grams—many of whom pursue graduate study on a part-time basis whilecontinuing to work—the economic and career advancement benefits of thedegree are far more modest. This further suggests that those who argue that theMBA necessarily opens innumerable opportunities to pursue new trades orprofessions have, at best, not undertaken sufficient study of the facts behindtheir conclusions.

Admittedly, the MBA degree remains an economically lucrative—and per-haps even career-transforming—credential for students at a small number ofelite business schools. At top business schools, such as the Harvard BusinessSchool and the University of Chicago Booth School of Business, starting annualcompensation for MBA graduates exceeds $100,000 by wide margins.71 More-over, MBA students at such schools remain heavily recruited by elite firms that,while not requiring the MBA degree for entry or promotion, maintain substan-tial recruiting pipelines at top schools.72 Clearly, the graduates of these eliteinstitutions enjoy opportunities to not only substantially—and relativelyquickly73—increase their annual compensation by considerable amounts, but

70. Even this scenario, however, is perhaps far less common than it might appear. Most businessschools, particularly the elite institutions most likely to confer career-transforming benefits on theirgraduates, typically require at least some relevant work experience as a prerequisite for admission. See,e.g., Harvard Business School, Who Are We Looking For?, http://www.hbs.edu/mba/admissions/ (lastvisited Jan. 30, 2009) (noting that most candidates for admission to the Harvard Business School areoptimally prepared after at least two or three years of post-college work experience).

71. See Schools of Business, U.S. NEWS & WORLD REP., Apr. 2009, 20–21 (reporting base salaries of$115,665 and $103,219, and total compensation—including bonuses—of $135,630 and $126,818 for2007 graduates of Harvard and Chicago Booth, respectively).

72. See, e.g., Harvard Business School, Recruiting Partners, http://www.hbs.edu/recruiting/printready/statistics-mba.html (last visited May 15, 2009) (referring to campus recruiting efforts at the HarvardBusiness School by McKinsey & Company, Merrill Lynch, Bain & Company, Barclays Capital, andnumerous other elite firms); McKinsey & Company, M.B.A. Candidates, http://www.mckinsey.com/careers/is_mckinsey_right_for_me/backgrounds_like_yours/mba.aspx (last visited Mar. 4, 2009) (refer-ring, via a long drop-down window, to McKinsey & Company’s recruiting efforts at a list of elitebusiness schools, including Harvard, Stanford, Pennsylvania, Columbia, and Chicago).

73. The completion of an MBA program requires no more than two years of full-time study. See,e.g., University of Chicago Booth School of Business, Full-Time MBA Curriculum, http://


also to attract the attention of elite firms that might not otherwise give themmore than a passing look. One must concede that such lucrative and perhapseven career-transforming benefits are not within the spirit of § 162(a) to theextent that that statutory provision contemplates deduction of the costs of doingbusiness, but not the costs of self-transformation and wholesale reinvention. It isperhaps these elite business students that stand foremost in the minds of thosewho advocate blanket disallowance of deductions for MBA-related expendi-tures.

The reality, however, is that all but a small percentage of the many thousandsof MBA students in the United States fall well outside of the elite schoolcontext. For most MBA students, many of whom pursue their studies on apart-time basis while continuing to work, the economic and transformationalbenefits that flow from their degrees are far more modest. Today, more than 900colleges and universities in the United States award the MBA degree, with theannual total number of MBA degrees awarded exceeding 100,000.74 Of thedegrees awarded, only twenty percent are conferred upon students pursuingfull-time study in traditional two-year programs; the vast majority of theremainder go to working professionals in part-time programs.75 Moreover, forthose who pursue their degrees at the 800-plus institutions that fall outside theelite category comprising the top twenty schools, the economic rewards are farless compelling.76 At DePaul University’s Kellstadt School of Business, forinstance, the typical 2007 MBA graduate earned a starting base salary of$66,929,77 a figure nearly $50,000 lower than that of the average 2007 Harvardgraduate78 and nearly $40,000 lower than that of a graduate of the school’scross-town neighbor, the University of Chicago Booth School of Business.79 Atthe flagship branch of the University of Missouri, the 2007 starting base salaryfigure was $56,400.80 At the University of Kentucky, the figure was $46,991,81

a number that actually fell below the 2007 national average for students earningundergraduate degrees in economics, finance, and management informationsystems.82 Furthermore, a brief glance at the recruiting schedules of the most

www.chicagogsb.edu/fulltime/academics/curriculum/index.aspx (last visited Apr. 22, 2009) (indicatingthat the twenty-one-course, full-time MBA program at the University of Chicago Booth School ofBusiness is completed over a two-year period).

74. See Pfeffer & Fong, supra note 22, at 78.75. See Kurt Badenhausen & Lesley Kump, Part-Time Fever, FORBES, Sept. 5, 2005, at 148.76. See Pfeffer & Fong, supra note 22, at 78 (noting that the economic benefits of MBA study accrue

“mostly to graduates of the more prestigious programs” and citing a study showing that individualsfrom less competitive programs “earned amounts that were more similar to people who either did notattend business school at all or who did not graduate”).

77. See Directory, U.S. NEWS & WORLD REP., supra note 71, at 82.78. Id. at 88.79. Id. at 83.80. Id. at 91.81. Id. at 85.82. See Rob Kelley, Most Lucrative College Degrees, CNNMONEY.COM, July 11, 2007, http://

money.cnn.com/2007/07/11/pf/college/starting_salaries/index.htm (reporting that 2007 graduates earn-


elite professional services firms—those paying six-figure salaries and providingtheir recruits with entree into elite professions like investment banking andmanagement consulting—reveals that such firms focus their hiring efforts on asmall number of elite institutions, most of which do not offer part-time study.83

All of this leads one to a composite image of the typical MBA student: amodestly-compensated working professional pursuing MBA study on a part-time basis at a non-elite school, motivated by a desire to enhance his businessskills and thus improve his career prospects in the long-term—quite simply, astudent much like the taxpayers in Allemeier and Blair.

These observations together dispel the common misconception of the arche-typal MBA student as a career-changing, soon-to-be-highly-compensated, futureWall Street “shark” or high-end management consultant.84 Although MBAstudents of that ilk do in fact exist—Harvard graduates them at a rate of morethan 900 per year85—a more accurate conception of the common MBA is onewhose ambitions are more modest and arguably more in line with the policymotivations behind § 162. As will be discussed briefly in section II.C, thesefindings counsel against blanket disallowance of deductions for MBA-relatedexpenses and instead point toward the need for modifications to TreasuryRegulation § 1.162-5 that will more cleanly separate those MBAs whoseeducations conform to § 162 from those whose educations plainly flaunt itspurposes.

ing undergraduate degrees in economics, finance, and management information systems reportedaverage starting salaries of $48,483, $47,239, and $47,648, respectively).

83. See, e.g., McKinsey & Company, M.B.A. Candidates, http://www.mckinsey.com/careers/is_mckinsey_right_for_me/backgrounds_like_yours/mba.aspx (last visited Mar. 4, 2009) (showing thatMcKinsey & Company’s active MBA recruiting plans for the 2008–2009 academic year include onlyeighteen U.S. business schools, none of which ranks lower than nineteen in U.S. News & WorldReport’s 2009 ranking of the top business schools). For other schools from which McKinsey recruits,the firm permits applications from students via an online recruiting site, but does not actively recruit oncampus. See id. The U.S. News rankings of these “online application-only” schools range fromseventeen (Carnegie Mellon) to forty-eight (Babson), with one of the schools (Pittsburgh) not appearingon the magazine’s list of the top fifty schools at all. In any event, it remains plain that McKinsey’sactive MBA recruiting efforts generally do not extend far beyond the twenty or so most elite schools.For a complete list of the U.S. News rankings associated with the schools listed on McKinsey’srecruiting web site, see Schools of Business, supra note 71, at 20.

84. One need look no further than the popular press for evidence of this not uncommon misconcep-tion of the typical MBA. See, e.g., Having an MBA Never Hurts, GRAND RAPIDS PRESS, Oct. 5, 2003, atE1 (contrasting employed, down-to-earth, part-time MBA students with the stereotypical image of “apreoccupied man in a three-piece suit with crisp $50 bills stuffed into his pockets” and images of thosepursuing “a golden ticket to the big-time promotions and bonuses associated with the East Coast’smost-lauded business schools”); Thomas Kostigen, Beyond Dollar Signs: MBA Students See Green asthe Way to Go, MARKETWATCH, Aug. 7, 2008, http://www.marketwatch.com/story/mba-students-see-green-as-the-way-to-go?dist�msr_1 (describing the stereotypical MBA as one “looking to make his or hermark on the world through a successful career on Wall Street”).

85. See Schools of Business, supra note 71, at 20 (pegging the Harvard Business School’s totalfull-time enrollment at more than 1800 students).


C. THE OBVIOUS OVERBREADTH OF BLANKET DISALLOWANCE

Given the differences between the MBA and degrees that lead to certificationor licensure in new trades or professions, and given that a large percentage ofMBA graduates do not reap the transformative benefits that accrue to graduatesof the most elite schools, it remains plain that—for at least some graduates—completion of the degree results in the maintenance or improvement of existingskills and little more. For such individuals, pursuit of the degree falls squarelywithin the four corners of the policy motivations of § 162, which seek to permitdeductions for costs associated with continuing in one’s current trade or busi-ness but not for those that lead to broader career transformation. Accordingly, ablanket disallowance of deductions for MBA-related expenses would result inan overbroad rule that would unnecessarily disqualify many taxpayers whoseeducations do not violate the letter or spirit of § 162.

A closer examination of the facts of the Allemeier case brings this conclusioninto focus. The Allemeier taxpayer first joined his employer, a small dentalappliance manufacturer, as an entry-level salesperson in 1996.86 His early dutieswith the company included making sales calls via telephone, managing smallbudgets, and working with business partners and customers to educate them onuse of the company’s products.87 The company thought very highly of thetaxpayer’s performance during his early tenure and swiftly promoted him intomore demanding roles. By the time he chose to pursue a part-time MBA atPepperdine University in 1999, the taxpayer had risen to become a top salesper-son within the firm. Moreover, his responsibilities had broadened considerablyto include the following: designing marketing strategies, organizing informa-tional seminars, traveling extensively to promote the company’s products intalks at dentistry conventions, analyzing financial reports, and assessing theeffectiveness of marketing campaigns. Moreover, shortly after commencing hisMBA studies, but long before he completed his degree, the company promotedthe taxpayer to the position of Marketing Manager. At all times during thepursuit of his MBA, the taxpayer remained employed with the company on afull-time basis. Among the courses he took while pursuing his MBA were thefollowing: “accounting for managers, statistics, managerial finance, marketingmanagement, quantitative methods, negotiation and conflict resolution, organiza-tional theory and management, and business strategy.” The taxpayer completedhis degree in 2001.

If those who call for blanket disallowance of deductions for MBA-relatedexpenditures are correct, the Allemeier taxpayer’s MBA degree surely musthave resulted in his virtually automatic ability to “enter many new trades andbusinesses.”88 And yet, on close inspection, one struggles to contemplate pre-cisely what those “many new trades and businesses” might be. By virtue of his

86. Allemeier v. Comm’r, 90 T.C.M. (CCH) 197, 198 (2005).87. Id.88. See Sanchez, supra note 3, at 676.


pre-MBA business experiences, the Allemeier taxpayer had already establishedhimself as a general manager, marketing manager, marketing analyst, businessstrategist, business development manager, and financial analyst, among otherfunctions. Moreover, his MBA curriculum was fairly narrowly tailored toinclude only those subject areas in which he had previously developed a certaindegree of competence, making it difficult for the Commissioner to argue that hehad somehow positioned himself for entry into wholly new professional enter-prises.89 Further still, he, like the vast majority of MBA students, pursued hisgraduate studies on a part-time basis at a business school of modest stature—inthis case, Pepperdine University—and not at the sort of elite institution likely topresent him with opportunities to enter exclusive, highly selective industrieslike Wall Street investment banking or high-end management consulting. Sim-ply put, though it may be possible to conceive of some specific job or positionfor which the Allemeier taxpayer may have become qualified only after complet-ing his MBA—as would be the case, it must be noted, with virtually any formof education, including those expressly permitted by § 1.162-590—the argumentthat he somehow became qualified in “many new trades or businesses” simplyby virtue of his graduate degree is untenable.

Ultimately, a careful examination of the facts of the Allemeier case reveals ataxpayer whose educational expenditures—incurred in an effort to improveexisting skills and not to effect a wholesale career reinvention or to facilitateentry into some grand new trade or enterprise—were wholly within the letterand spirit of § 162 and Treasury Regulation § 1.162-5. Given the existence ofMBA students like the taxpayer in Allemeier, the ultimate effect of a blanketdisallowance would be to prohibit deductions for, and perhaps even discourage,education undertaken in order to legitimately improve one’s effectiveness as abusinessperson or manager. It seems, then, that the more prudent and fairapproach to preventing abuse of § 1.162-5 would be to identify changes to theregulation that would make inappropriate deductions less likely. Such is thegoal of the third and final Part of this Note.

III. A NEW WAY FORWARD: PROPOSED MODIFICATIONS TO TREASURY REGULATION

§ 1.162-5

Three relatively simple amendments to Treasury Regulation § 1.162-5 would,

89. At trial, the Commissioner argued that the taxpayer’s MBA education had qualified him to enterthe “new trade or business of ‘advanced marketing and finance management,’” an argument which theTax Court found unconvincing. See Allemeier, 90 T.C.M. (CCH) at 200.

90. The regulation indicates, for instance, that a psychiatrist would be permitted to deduct the costsassociated with “a program of study and training at an accredited psychoanalytic institute which willlead to qualifying him to practice psychoanalysis.” Treas. Reg. § 1.162-5(b)(3)(ii), Example (4) (asamended in 1967). Clearly, one could conceive of jobs or positions that might require training inpsychoanalysis in addition to a degree and licensing in psychiatry. Nevertheless, the regulationindicates that coursework toward qualification in psychoanalysis would be wholly deductible under§ 162.


without implementing blanket disallowance of MBA-related expenditures, serveto separate educational expenditures that violate the purpose of § 162 fromthose that legitimately improve or maintain existing skills while not resulting inqualification in new trades, professions, or businesses. Each of these amend-ments is informed by one or more of the core concerns gleaned from the MBAcases analyzed in section I.B: general disapproval of extended full-time study,disapproval of career transformation, and disapproval of study in areas in whichthe taxpayer has not already obtained substantial professional experience. Thethree recommended amendments, each of which will be outlined in detailbelow, are as follows: first, a prohibition of deductions for expenses incurred aspart of a program of study in which the taxpayer engages in extended full-timestudy; second, an express requirement that deduction eligibility be determinedon a course-by-course basis; and third, implementation of a “twenty-five per-cent” rule that would disallow deductions for expenses incurred as part of aprogram of study in which more than twenty-five percent of courses fall in areasin which the taxpayer had not previously obtained substantial professionalexperience.

A. PROHIBITION OF EXTENDED FULL-TIME STUDY

The first of the three recommended amendments to Treasury Regulation§ 1.162-5 would prohibit deductions for expenses incurred as part of a programof study in which the taxpayer engaged, or will engage, in extended full-timestudy. The text of the amendment might read as follows:

Any educational expenses incurred in pursuit of an academic program ofstudy in which the taxpayer engaged, or plans to engage, in full-time study—defined as twelve or more academic credit hours in a single semester, or theequivalent—for more than two academic semesters (or the equivalent)91 arenot deductible under § 162(a). This prohibition applies not only to expensesincurred for courses taken while studying full-time, but also to expensesincurred while studying part-time if those expenses were incurred as part of aprogram of study in which the taxpayer at some time engaged, or will at sometime engage, in full-time study for more than two semesters (or the equiva-lent). This prohibition also applies even where the taxpayer continued topractice—whether as an employee or as the operator of a business—in hisestablished trade or profession while engaged in full-time study.

The purpose of this amendment would be to prohibit students from attempt-ing to characterize a two-year, full-time, career-transforming degree as a tempo-rary, skills-enhancing sabbatical from one’s established trade or profession.Consistent with the case law analyzed in section I.B, the amendment would

91. At an institution that follows a quarter system, for example, the equivalent of more than twosemesters of twelve or more credit hours would be more than three quarters of eight or more credithours.


have the effect of more cleanly separating the career-changing Harvard Busi-ness School student92 from the personnel manager93 or marketing manager94

intent on pursuing an MBA in order to improve his existing skills. Furthermore,by noting that the full-time study prohibition does not dissolve merely becausethe taxpayer continued to work while studying on a full-time basis, the amend-ment would prevent a taxpayer from arguing that, by virtue of an internship orpart-time job, he remained engaged in a trade or profession while pursuing afull-time degree.

At the same time, however, by not expressly disallowing deductions foreducational expenses incurred as part of a program of study involving two orfewer semesters of full-time study (or the equivalent), the amendment wouldpreserve deductions for, say, a one-year master’s degree in education,95 orperhaps a summer of full-time study undertaken by an elementary schoolteacher in pursuit of a master’s degree in his area of specialty. Given TreasuryRegulation § 1.162-5’s apparent policy preference for educational deductions byteachers,96 the drafting of the amendment to preserve such options wouldappear to be prudent, and perhaps necessary, in order to maintain existingTreasury Department policy.

B. COURSE-BY-COURSE EVALUATION OF DEDUCTION ELIGIBILITY

The second of the three proposed amendments would expressly state thatdeduction eligibility must be determined on a course-by-course basis. The textof the amendment might read as follows:

Where a taxpayer has pursued education as part of a multi-course program ofstudy, eligibility for deduction under § 162 must be determined on a course-by-course basis. For instance, where a broad program of study improves ormaintains skills used in the taxpayer’s established trade or business, but wherecertain courses in that broader program of study fall in areas in which thetaxpayer did not have substantial professional experience prior to commenc-ing his studies, the taxpayer may claim a deduction only for those courseswhich explore areas in which he had previously demonstrated substantial

92. See Foster v. Comm’r, T.C. Summ. Op. 2008-22; Schneider v. Comm’r, 47 T.C.M. (CCH) 675,679 (1983).

93. See Blair v. Comm’r, 41 T.C.M. (CCH) 289, 290 (1980).94. See Allemeier v. Comm’r, 90 T.C.M. (CCH) 197, 198 (2005).95. Typically, a master’s degree in education can be completed in two semesters of full-time study.

See, e.g., Harvard Graduate School of Education, Academic Programs, http://www.gse.harvard.edu/academics/index.html (last visited Mar. 24, 2009) (noting that it takes one year to complete a master ofeducation degree, or Ed.M., at the Harvard Graduate School of Education).

96. See Treas. Reg. § 1.162-5(b)(3)(i) (as amended in 1967) (asserting that “all teaching and relatedduties shall be considered to involve the same general type of work,” and that a classroom teacher’stransfer to another subject area, transfer from an elementary school to a secondary school, transfer intoa guidance counselor role, or elevation to principal will not constitute a transition into a new trade orbusiness within the meaning of § 1.162-5).


competence, as only those courses can be said to have maintained or im-proved the taxpayer’s existing skills.97

Though perhaps already implicit in the existing incarnation of § 1.162-5, thisamendment would explicitly prevent a taxpayer from broadly characterizing aneducational program as one that improves or maintains his existing skills andthen proceeding to declare deductions for all courses in that program—including those that provided instruction in areas entirely new to the taxpayer.Moreover, by expressly disallowing deductions for all courses covering areas inwhich the taxpayer had no prior exposure, the amendment would place prospec-tive students on notice that, in order for an MBA education—or any type ofeducation—to be deductible, course selection must be tailored to subject areasin which the student has already established some substantial degree of compe-tence.98

97. Admittedly, terms such as “substantial professional experience” and “substantial competence”could themselves serve as the subject of considerable litigation and therefore may need to be moreclearly defined in any adopted amendment(s) to Treasury Regulation § 1.162-5. One might, forinstance, define “substantial professional experience” more precisely as follows: “extensive profes-sional practice, engaged in as a significant component of one’s core job responsibilities, for a period ofsix months or longer.” While it would be virtually impossible to rid Treasury Regulation § 1.162-5 ofall subjectivity, the amendments proposed here would, as noted, have the benefit of placing taxpayerson notice that one cannot simply put forward one’s general competence as a “businessperson” or“manager” as an excuse to sweep an entire degree program—much of which confers entirely newskills—under the umbrella of a general improvement of one’s preexisting “business skills.” Anapproach much like this one seems to have worked well in Blair v. Commissioner, where, as noted insection I.B.2, supra, the court found that all of the courses at issue in that case, with the exception of asingle course for which the taxpayer did not claim a deduction, improved or maintained skills that thetaxpayer had already acquired in her job. See Blair v. Comm’r, 41 T.C.M. (CCH) 289, 292 (1980). InBlair, then, it would seem that the taxpayer and the court were both able to separate those courses thatimproved the taxpayer’s existing skills from one that plainly did not, a fact that offers some promise forthe approach outlined here. Although there will undoubtedly be close cases under any regulatoryscheme, the amendments proposed in this Note would mark a vast improvement over the existingincarnation of Treasury Regulation § 1.162-5, which leaves considerable room for the sort of broaddeductibility the courts have generally found unacceptable.

98. Another possible criticism of this proposed amendment is that it would give rise to considerablecompliance and enforcement complexities. How, one might ask, would an IRS auditor determine ataxpayer’s eligibility for educational expenditure deductions on a course-by-course basis withoutengaging in extensive and time-consuming review of the taxpayer’s academic record and employmenthistory, not to mention detailed review of the intricacies of the course offerings at the taxpayer’seducational institution? Admittedly, the implementation of this amendment would present enforcementchallenges. One possible way to alleviate such complexities would be to require any taxpayer wishingto take a § 162 deduction for educational expenditures to complete a form on which he would berequired to (1) list each course for which he intended to take a deduction; (2) provide the specific costassociated with each individual course; and (3) provide a brief description of (a) the specific existingskills which each course maintained or improved, and/or (b) the extent to which his employer requireda given course as a condition to the retention of his established employment, status, or rate ofcompensation. Although the use of such a form would not eliminate all compliance and enforcementchallenges, it would alleviate such complexities in two ways. First, it would force the taxpayer to assert,under penalty of perjury, that each and every course for which he was taking a deduction complied withthe requirements of Treasury Regulation § 1.162-5, which would in turn place the taxpayer on noticethat he could not escape enforcement or penalties merely by asserting that his broader program of study


C. IMPLEMENTATION OF A “TWENTY-FIVE PERCENT” RULE

Finally, the third of the three proposed amendments would implement a“twenty-five percent” rule that would disallow deductions for expenses incurredas part of a program of study in which more than twenty-five percent of coursesfall in areas in which the taxpayer had not previously obtained substantialprofessional experience. The text of this final amendment might read as follows:

Where a taxpayer has pursued education as part of a multi-course program ofstudy, and where more than twenty-five percent of the courses pursued as partof that program fall in areas in which the taxpayer had not previouslyobtained substantial professional experience, the taxpayer may not claim adeduction for expenses associated with any of the courses in the program ofstudy—even those which provided instruction in areas in which the taxpayerhad previously obtained substantial professional experience.

This amendment would establish a presumption that any academic course ofstudy in which more than a quarter of the courses selected did not maintainexisting skills will almost certainly have the effect of qualifying the taxpayer innew trades or professions. While allowing for the fact that any course ofstudy—even one generally compliant with § 162—may mandate a handful ofrequired courses that do not map to a taxpayer’s existing skill set, this amend-ment would make it difficult for a taxpayer to shoe-horn a truly transformationaldegree program into Treasury Regulation § 1.162-5’s mandate that educationimprove or maintain existing skills and not qualify the taxpayer in a new tradeor business. Moreover, like the previous amendment, this proposal would placetaxpayers on notice that narrow-tailoring of course selection would be critical toobtaining deductibility of educational expenditures.

* * *If implemented, the three amendments outlined here would not only have the

effect of more cleanly separating legitimate deductions from those likely toviolate the policy motivations behind § 162, but would also serve to providetaxpayers and courts with critical guidance in what has, over the course of thepast forty years, emerged as a rather confusing area of the tax law. Given thatTreasury Regulation § 1.162-5 has remained unchanged since 1967, it would

served to maintain or improve his existing skills in some general sense. In other words, the form wouldprovide a strong disincentive to engage in bad faith efforts to skirt § 1.162-5’s requirements. Second,the form would provide an auditor with a tool for identifying possible compliance problems because itmight expose specific instances—such as a chemical engineer’s attempt to claim a deduction for amarketing course—in which a taxpayer’s claim for a deduction appeared to exceed the boundaries of§ 1.162-5. While the use of such a form would add some complexity to the compliance process, thenew procedure required would arguably be no more cumbersome than others commonly used by theIRS. For instance, IRS Form 8283, which requires detailed documentation of non-cash charitablecontributions, demands at least as much of the taxpayer as the form proposed here—particularly wherethe value of any of the taxpayer’s non-cash donations exceeds $500. See Internal Revenue ServiceForm 8283, Noncash Charitable Contributions (rev. Dec. 2006).


seem that it is now more than ripe for revisions of the sort proposed here.

CONCLUSION

Although the line of Tax Court cases considering the deductibility of MBA-related tuition expenses may at first appear to be a confusing and winding mazeof inconsistency, more careful inspection reveals that—in most cases—thecourts probably got it right. For the most part, MBA students at elite schoolswho attempted to take enormous tax deductions for career-transforming educa-tional experiences were turned away,99 whereas those toiling away in an effortto improve their established business skills while continuing to work full-timewere permitted to take their deductions.100 In short, at the end of the day itappears as if the courts generally muddled through the cluttered, outdated messthat is Treasury Regulation § 1.162-5 and came out with the right answers.

This is not to say, however, that all is well. As recent commentators havenoted, the standards outlined in § 1.162-5 are difficult for courts to apply, andeven more difficult for the lay taxpayer to comprehend. Perhaps that is onereason why at least one commentator has thrown her hands up and called forblanket disallowance of MBA-related expenditures.101 If it is difficult on reason-able inspection to determine when, if ever, MBA-related educational expendi-tures should be deductible, then why not simply disallow the deduction of suchexpenditures altogether?

As this Note has shown, the implementation of such a drastic approach wouldbe both unnecessary and unfair. For one, it is plain that—stereotypes aside—notall MBA educations offend the purposes of § 162. In addition, as demonstratedin Part III, the Treasury Department need only make a handful of straightfor-ward and long overdue changes to § 1.162-5 to make the parameters governingdeductibility of educational expenditures more comprehensible for taxpayers,tax attorneys, and courts alike. Accordingly, it would seem that the solution tothe problem is entirely attainable. What remains to be seen, however, is whetherthe Treasury Department will attempt to make that attainment a reality.

99. See, e.g., Foster v. Comm’r, T.C. Summ. Op. 2008-22; McEuen v. Comm’r, T.C. Summ. Op.2004-107; Schneider v. Comm’r, 47 T.C.M. (CCH) 675, 680 (1983).

100. See, e.g., Allemeier v. Comm’r, 90 T.C.M. (CCH) 197, 201 (2005); Blair v. Comm’r, 41 T.C.M.(CCH) 289, 292 (1980).

101. See Sanchez, supra note 3, at 676.


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